The Little Book of Common Sense Investing

The Little Book of Common Sense Investing......Page 3
Contents......Page 13
Introduction to the 10th Anniversary Edition......Page 17
Chapter One A Parable The Gotrocks Family......Page 35
 Get rid of all your Helpers. Then your family will again reap 100 percent of the pie that corporate America bakes for you......Page 38
Chapter Two Rational Exuberance: Shareholder Gains Must Match Business Gains......Page 43
 “Over time, the aggregate gains made by . . . shareholders must of necessity match the business gains of the company......Page 44
 Reversion to the mean......Page 47
 “It is dangerous . . . to apply to the future inductive arguments based on past experience.”......Page 48
 The dual nature of stock market returns......Page 49
 Enter speculative return......Page 51
 A return to sanity......Page 52
 Accurately forecasting short-term swings in investor emotions is not possible. But forecasting the long-term economics of investing has carried remarkably high odds of success......Page 53
 The real market and the expectations market......Page 54
 The stock market is a giant distraction to the business of investing......Page 55
Chapter Three Cast Your Lot with Business: Win by Keeping It Simple—Rely on Occam’s Razor......Page 59
 Occam’s razor: When there are multiple solutions to a problem, choose the simplest one......Page 60
 The Total Stock Market Index......Page 61
 Returns earned in the stock market must equal the gross returns earned by all investors in the market......Page 64
 If the data do not prove that indexing wins, well, the data are wrong......Page 65
 Active funds versus benchmark indexes......Page 66
 The record of an investor in the first index mutual fund: $15,000 invested in 1976; value in 2016, $913,340......Page 68
 A caveat and a caution......Page 69
Chapter Four How Most Investors Turn a Winner’s Game into a Loser’s Game: “The Relentless Rules of Humble Arithmetic”......Page 73
 Before costs, beating the market is a zero-sum game. After costs, it is a loser’s game......Page 74
 We investors as a group get precisely what we don’t pay for. If we pay nothing, we get everything......Page 76
 “The relentless rules of humble arithmetic.”......Page 77
 It’s amazing how difficult it is for a man to understand something if he’s paid a small fortune not to understand it......Page 78
 $10,000 grows to $294,600 . . . or to $114,700. Where did that $179,900 go?......Page 80
 You put up 100 percent of the capital and you assume 100 percent of the risk. But you earn less than 40 percent of the potential return......Page 82
 Costs make the difference between investment success and investment failure......Page 83
 Fund investors deserve a fair shake......Page 84
Chapter Five Focus on the Lowest-Cost Funds: The More the Managers Take, the Less the Investors Make......Page 87
 Fund performance comes and goes. Costs go on forever......Page 88
 Costs are large, and too often ignored......Page 90
 Costs matter. A lot......Page 91
 The magic of compounding, again......Page 93
 Low costs and index funds......Page 94
 If the managers take nothing, the investors receive everything: the market’s return......Page 95
Chapter Six Dividends Are the Investor’s (Best?) Friend: But Mutual Funds Confiscate Too Much of Them......Page 99
 An astonishing revelation......Page 100
 Actively managed equity funds confiscate your dividend income......Page 103
Chapter Seven The Grand Illusion: Surprise! The Returns Reported by Mutual Funds Are Rarely Earned by Mutual Fund Investors......Page 107
 Hint: Money flows into most funds after good performance, and goes out when bad performance follows......Page 108
 The dual penalties of costs and investor behavior......Page 109
 Inflamed by heady optimism and greed, and enticed by the wiles of mutual fund marketers, investors poured their savings into equity funds at the bull market peak......Page 112
 When counterproductive investor emotions are magnified by counterproductive fund industry promotions, little good is apt to result......Page 113
 Investor emotions plus fund industry promotions equals trouble......Page 115
Chapter Eight Taxes Are Costs, Too: Don’t Pay Uncle Sam Any More Than You Should......Page 119
 Managed mutual funds are astonishingly taxinefficient......Page 120
 Bring on the data!......Page 121
 Fund returns are devastated by costs, adverse fund selections, bad timing, taxes, and inflation.......Page 123
 Nominal returns versus real returns......Page 124
Chapter Nine When the Good Times No Longer Roll: It’s Wise to Plan on Lower Future Returns in the Stock and Bond Markets......Page 127
 Both common sense and humble arithmetic tell us that we’re facing an era of subdued returns in the stock market......Page 129
 The arithmetic behind the caution: the sources of stock returns......Page 131
 Future annual speculative return— minus 2 percent?......Page 132
 If you don’t agree with my 4 percent expectation, “do it yourself.”......Page 133
 The source of bond returns—the current interest yield......Page 134
 With lower returns are in prospect for stocks and bonds, balanced stock/bond portfolios will follow suit......Page 137
 If rational expectations suggest a future gross annual return of 3.6 percent for a balanced fund, what does this imply for the net return to owners of the balanced fund?......Page 139
 Unless the fund industry begins to change, the typical actively managed fund appears to be a singularly unfortunate investment choice......Page 140
 Five ways to avoid financial devastation. Only two work......Page 141
Chapter Ten Selecting Long-Term Winners: Don’t Look for the Needle—Buy the Haystack......Page 145
 A fund failure rate of almost 80 percent......Page 147
 The odds against success are terrible: Only two out of 355 funds have delivered truly superior performance......Page 148
 The Magellan Fund story......Page 149
 The Contrafund story......Page 151
 Living by the sword, dying by the sword......Page 153
 Look (forward) before you leap......Page 154
 Don’t look for the needle, buy the haystack......Page 155
 Indexing for a lifetime. Two major options: Investing in 30 or 40 active funds and managers, or in one index fund with one non-manager......Page 156
 If you decide against indexing . . .......Page 157
Chapter Eleven “Reversion to the Mean”: Yesterday’s Winners, Tomorrow’s Losers......Page 161
 Reversion to the mean (RTM) is reaffirmed in comprehensive fund industry data......Page 162
 A second study reaffirms the first study—with incredible precision......Page 164
 The stars produced in the mutual fund field rarely remain stars; all too often they become meteors......Page 166
 Picking winning funds based on past performance is hazardous duty......Page 167
Chapter Twelve Seeking Advice to Select Funds?: Look Before You Leap......Page 173
 Registered investment advisers (RIAs) can play a vital role in providing investors with assistance......Page 174
 Helpers—adding value or subtracting value?......Page 175
 If you can avoid jumping on the bandwagon . . .......Page 176
 Average annual return of funds recommended by advisers: 2.9 percent. For equity funds purchased directly: 6.6 percent......Page 177
 The Merrill Lynch debacle: a case study......Page 178
 Two terrible ideas: the Focus Twenty fund and the Internet Strategies fund......Page 179
 A marketing success for Merrill Lynch, an investment failure for its clients......Page 180
 Investment disaster: Clients lose 80 percent of their assets......Page 181
 The rise of the robo-adviser......Page 182
 Simplicity beats complexity......Page 183
 The fiduciary standard......Page 184
Chapter Thirteen Profit from the Majesty of Simplicity and Parsimony: Hold Traditional Low-Cost Index Funds That Track the Stock Market......Page 187
 The Monte Carlo simulation......Page 188
 The majesty of simplicity in an empire of parsimony......Page 189
 My conclusions rely on mathematical facts—the relentless rules of humble arithmetic......Page 191
 All index funds are not created equal. Costs to investors vary widely......Page 192
 Two funds. One index. Different costs......Page 194
 Your index fund should not be your manager’s cash cow. It should be your own cash cow......Page 195
 Whether markets are efficient or not, indexing works......Page 196
 International funds also trail their benchmark indexes......Page 197
 Caution about gambling......Page 198
Chapter Fourteen Bond Funds: Where Those Relentless Rules of Humble Arithmetic Also Prevail......Page 201
 Why would an intelligent investor hold bonds?......Page 202
 A similar gap between bond yields and stock yields......Page 203
 Bonds vary in riskiness......Page 204
 Three basic types of bond funds......Page 205
 Like stock funds, actively managed bond funds lag their benchmarks. Why? The arithmetic of costs......Page 206
 The important role of costs in shaping bond fund returns......Page 207
 The total bond market index fund......Page 208
 The value of bond index funds is created by the same forces that create value for stock index funds......Page 209
Chapter Fifteen The Exchange-Traded Fund (ETF): A Trader to the Cause?......Page 213
 ETF traders have absolutely no idea what relationship their investment returns will bear to the returns earned in the stock market......Page 214
 The creation of the “Spider.”......Page 215
 The ETF stampede......Page 217
 The renowned Purdey shotgun is great for big-game hunting in Africa. It’s also an excellent weapon for suicide......Page 220
 The temptation to chase past returns......Page 221
 Among the 20 best-performing ETFs, for 19 funds, investor returns fell short of ETF returns......Page 222
 A “double whammy”: betting on hot market sectors (emotions) and paying heavy costs (expenses) are sure to be hazardous to your wealth......Page 223
 ETFs are a dream come true for entrepreneurs and brokers. But are they an investor’s dream come true?......Page 224
 Answering my question......Page 225
Chapter Sixteen Index Funds That Promise to Beat the Market: The New Paradigm?......Page 229
 Success breeds competition......Page 230
 Active managers versus active strategies......Page 231
 Not a terrible idea, but not a world-changing one, either......Page 233
 “Remembrance of things past.”......Page 234
 Recent events confirm skepticism about the power of smart beta......Page 235
 “The new Copernicans”?......Page 236
 Let’s look at the record......Page 237
 “The greatest enemy of a good plan is the dream of a perfect plan.” Stick to the good plan......Page 238
Chapter Seventeen What Would Benjamin Graham Have Thought about Indexing?: Mr. Buffett Confirms Mr. Graham’s Endorsement of the Index Fund......Page 243
 Investors should be satisfied with the reasonably good return obtainable from a defensive portfolio......Page 244
 Wall Street—“a Falstaffian joke.”......Page 245
 The truth about mutual fund managers......Page 246
 “Unsoundly managed funds can produce spectacular but largely illusionary profits for a while, followed inevitably by calamitous losses.”......Page 247
 “The real money in investment will have to be made. . . not out of buying and selling but of owning and holding securities . . . [for their] dividends and benefitting from their long-term increase in value.”......Page 248
 The Graham 1949 strategy—precursor to the 1976 index fund......Page 249
 “I see no reason why they [investors] should be content with results inferior to those of an indexed fund.”......Page 250
 The down-to-earth basics of portfolio policy......Page 251
 Finding superior value was once a rewarding activity, but no longer......Page 252
 “To achieve satisfactory investment results is easier than most people realize.”......Page 253
Chapter Eighteen Asset Allocation I: Stocks and Bonds: When You Begin to Invest. As You Accumulate Assets. When You Retire.......Page 257
 Ninety-four percent of the differences in portfolio returns is explained by asset allocation......Page 258
 Benjamin Graham’s standard division: 50/50......Page 259
 Asset allocations and differences in yields......Page 260
 Bumps along the road......Page 261
 Ability to take risk, willingness to take risk......Page 262
 A basic allocation model for the investor who is accumulating assets, and the investor who is retired......Page 263
 Four decisions......Page 264
 The link between risk premiums and cost penalties......Page 265
 Low costs enable lower-risk portfolios to provide higher returns than higher-risk portfolios......Page 267
 A human perspective: advice to a worried investor......Page 268
Chapter Nineteen Asset Allocation II: Retirement Investing, and Funds That Set Your Asset Allocation in Advance......Page 271
 The wisdom of Benjamin Graham, again......Page 274
 The need for flexibility......Page 275
 “The checks are in the mail.”......Page 276
 Social Security payments plus index fund dividends—a sound basis for steady and growing income......Page 277
 Non-U.S. stocks—a new paradigm for allocation?......Page 278
 The advice in my 1993 book has worked out well......Page 279
 A fixed stock/bond ratio? Or a ratio that changes with investor goals, or with time?......Page 280
 The rise of the target-date fund (TDF).......Page 282
 Don’t forget Social Security......Page 283
 Social Security and asset allocation......Page 284
 The need to draw down capital......Page 288
 No guarantees......Page 289
Chapter Twenty Investment Advice That Meets the Test of Time: Channeling Benjamin Franklin......Page 293
 For all of the inevitable uncertainty amid the eternally dense fog surrounding the world of investing, there remains much that we do know......Page 294
 John Bogle and Benjamin Franklin: parallel investment principles......Page 296
 The way to wealth......Page 299
Acknowledgments......Page 303
EULA......Page 305